# Demonstration Problem

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Demonstration Problem
Accounting What the Numbers Mean 10e Demonstration Problem Chapter 2 – Problem 20 Prepare an Income Statement, Balance Sheet, and Statement of Changes in Stockholders’ Equity

Problem Definition The following information was obtained from the records of Shae, Inc.: Merchandise inventory \$132,000 Notes Payable (long-term) ,000 Sales ,000 Buildings and equipment ,000 Sales, general, and administrative expenses ,000 Accounts receivable ,000 Common stock (21,000 shares) ,000 Income tax expense ,000 Cash ,000 Retained earnings, 1/1/ ,500 Accrued liabilities ,000 Cost of goods sold ,000 Accumulated depreciation ,000 Interest expense ,000 Accounts payable ,000 Dividends declared and paid during ,500

balance sheet items reflect account balances at
Problem Definition Except as otherwise indicated, assume that all balance sheet items reflect account balances at December 31, 2013, and that all income state- ment items reflect activities that occurred during the year ended December 31, 2013. There were no changes in paid-in-capital during the year.

Problem Definition Prepare an income statement and statement of changes in stockholders’ equity for the year ended December 31, 2013, and a balance sheet at December 31, 2013, for Shae, Inc. What is the company’s average income tax rate? What interest rate is charged on long-term debt? What is the par value per share of common stock? e. What is the company’s dividend policy?

Problem Solution Prepare an income statement for the year ended December 31, 2013. Identify revenue and expense accounts: Revenues: Sales Expenses: Selling, general and administrative expenses Income tax expense Cost of goods sold Interest expense

Problem Solution Determine the order and presentation of the revenue and expense accounts: Gross Profit is the first subtotal shown. SHAE, INC. Income Statement For the Year Ended December 31, 2013 Sales \$450,000 Cost of goods sold (270,000) Gross profit \$180,000 Include a financial statement heading.

Problem Solution SHAE, INC. Sales \$450,000
Income Statement For the Year Ended December 31, 2013 Sales \$450,000 Cost of goods sold (270,000) Gross profit \$180,000 Selling, general, and admin. exp ( 36,000) Income from operations \$144,000 Income from operations (operating income) is a key measure of a firm’s financial performance for a period of time.

Problem Solution SHAE, INC. Sales \$450,000
Income Statement For the Year Ended December 31, 2013 Sales \$450,000 Cost of goods sold (270,000) Gross profit \$180,000 Selling, general, and admin. exp ( 36,000) Income from operations \$144,000 Interest expense ( 24,000) Income before taxes \$120,000 Interest expense is a non-operating expense.

Problem Solution SHAE, INC. Sales \$450,000
Income Statement For the Year Ended December 31, 2013 Sales \$450,000 Cost of goods sold (270,000) Gross profit \$180,000 Selling, general, and admin. exp ( 36,000) Income from operations \$144,000 Interest expense ( 24,000) Income before taxes \$ 120,000 Income tax expense ( 42,000) Net income \$ 78,000

Problem Solution Prepare a Statement of Changes in Stockholders’ Equity for the year ended December 31, 2013. SHAE, INC. Statement of Changes in Stockholders’ Equity For the Year Ended December 31, 2013 Paid-in capital: Retained earnings: Include a financial statement heading. Paid-in capital and retained earnings are the two primary components of stockholders’ equity.

Problem Solution SHAE, INC.
Statement of Changes in Stockholders’ Equity For the Year Ended December 31, 2013 Paid-in capital: Common stock \$105,000 Retained earnings: Paid-in capital includes common stock and additional funds paid-in, or contributed, by stockholders.

Problem Solution SHAE, INC. Paid-in capital: Common stock \$105,000
Statement of Changes in Stockholders’ Equity For the Year Ended December 31, 2013 Paid-in capital: Common stock \$105,000 Retained earnings: Beginning balance \$ 64,500 Net income for the year ,000 Less: Dividends declared and paid during year (19,500) Ending balance ,000 Net income increases and dividends decrease retained earnings.

Problem Solution SHAE, INC. Paid-in capital: Common stock \$105,000
Statement of Changes in Stockholders’ Equity For the Year Ended December 31, 2013 Paid-in capital: Common stock \$105,000 Retained earnings: Beginning balance \$ 64,500 Net income for the year ,000 Less: Dividends declared and paid during year (19,500) Ending balance ,000 Total stockholders’ equity \$228,000 Total stockholders’ equity is the sum of PIC and RE.

Problem Solution Prepare a balance sheet at December 31, 2013.
SHAE, INC. Balance Sheet December 31, 2013 Assets: Liabilities: Stockholders’ Equity: The report format of the balance sheet shows assets above liabilities and stockholders’ equity.

Problem Solution SHAE, INC.
Balance Sheet December 31, 2013 Assets: Cash \$ 96,000 Accounts receivable ,000 Merchandise inventory ,000 Total current assets \$288,000 Noncurrent assets Total assets Liabilities: Stockholders’ Equity: Total liabilities and stockholders’ equity Current assets are listed in order of liquidity, or nearness to cash.

Problem Solution SHAE, INC.
Balance Sheet December 31, 2013 Assets: Cash \$ 96,000 Accounts receivable ,000 Merchandise inventory ,000 Total current assets \$288,000 Buildings and equipment ,000 Less: Accumulated depreciation (108,000) ,000 Total assets \$432,000 Liabilities: Stockholders’ Equity: Total liabilities and stockholders’ equity Accumulated depreciation is a contra asset account.

Problem Solution SHAE, INC.
Balance Sheet December 31, 2013 Assets: Total assets \$432,000 Liabilities: Accounts payable \$ 45,000 Accrued liabilities ,000 Notes payable (long-term) ,000 Total liabilities \$204,000 Stockholders’ Equity: Total liabilities and stockholders’ equity As with assets, liabilities are often classified as current and noncurrent.

Problem Solution SHAE, INC.
Balance Sheet December 31, 2013 Assets: Total assets \$432,000 Liabilities: Total liabilities \$204,000 Stockholders’ Equity: Common stock \$105,000 Retained earnings ,000 Total stockholders’ equity ,000 Total liabilities and stockholders’ equity CS, RE, and Total SE are taken from the Statement of Changes in SE.

Problem Solution SHAE, INC.
Balance Sheet December 31, 2013 Assets: Total assets \$432,000 Liabilities: Total liabilities \$204,000 Stockholders’ Equity: Total stockholders’ equity ,000 Total liabilities and stockholders’ equity \$432,000 Total assets = Total liabilities + Total stockholders’ equity

Problem Solution SHAE, INC. Completed asset side of balance sheet.
December 31, 2013 Assets: Cash \$ 96,000 Accounts receivable ,000 Merchandise inventory ,000 Total current assets \$228,000 Buildings and equipment ,000 Less: Accumulated depreciation (108,000) ,000 Total assets \$432,000 Liabilities: Stockholders’ Equity: Total liabilities and stockholders’ equity Completed asset side of balance sheet.

Problem Solution SHAE, INC.
Balance Sheet December 31, 2013 Assets: Total assets \$432,000 Liabilities: Accounts payable \$ 45,000 Accrued liabilities ,000 Notes payable (long-term) ,000 Total liabilities \$204,000 Stockholders’ equity: Common stock \$105,000 Retained earnings ,000 Total stockholders’ equity ,000 Total liabilities and stockholders’ equity \$432,000 Completed liability and stockholders’ equity side.

Problem Solution Prepare an income statement and statement of changes in stockholders’ equity for the year ended December 31, 2013, and a balance sheet at December 31, 2013. What is the company’s average income tax rate? What interest rate is charged on long-term debt? What is the par value per share of common stock? e. What is the company’s dividend policy?

Problem Solution The company’s average income tax rate would be computed by dividing income tax expense by earnings before taxes: \$42,000 / \$120,000 = 35% average tax rate

Problem Solution Prepare an income statement and statement of changes in stockholders’ equity for the year ended December 31, 2013, and a balance sheet at December 31, 2013. What is the company’s average income tax rate? What interest rate is charged on long-term debt? What is the par value per share of common stock? e. What is the company’s dividend policy?

Problem Solution The interest rate charged on long-term debt is a function of interest expense divided by long-term debt: This assumes that the year-end balance of long-term debt is representative of the average long-term debt account balance throughout the year. \$24,000 / \$150,000 = 16% interest rate

Problem Solution e. What is the company’s dividend policy?
Prepare an income statement and statement of changes in stockholders’ equity for the year ended December 31, 2013, and a balance sheet at December 31, 2013. What is the company’s average income tax rate? What interest rate is charged on long-term debt? What is the par value per share of common stock? e. What is the company’s dividend policy?

\$105,000 / 21,000 shares = \$5 par value per share
Problem Solution The par value per share of common stock can be determined simply by dividing the dollar amount for common stock by the number of common shares outstanding: \$105,000 / 21,000 shares = \$5 par value per share

Problem Solution Prepare an income statement and statement of changes in stockholders’ equity for the year ended December 31, 2013, and a balance sheet at December 31, 2013. What is the company’s average income tax rate? What interest rate is charged on long-term debt? What is the par value per share of common stock? e. What is the company’s dividend policy?

\$19,500 / \$78,000 = 25% dividend payout policy
Problem Solution Shae, Inc. appears to have a policy of paying a fixed percentage of net income as a dividend to shareholders, computed as the dividends declared and paid divided by net income: \$19,500 / \$78,000 = 25% dividend payout policy

Accounting What the Numbers Mean 10e David H. Marshall
You should now have a better understanding of how to prepare financial statements. Remember that there is a demonstration problem for each chapter that is here for your learning benefit. David H. Marshall Wayne W. McManus Daniel F. Viele